From Financial Crisis to Bubble, Is the Next Cycle Now in Play?

What if the powerful breakout in the Dow Jones Transportation Average in December of 2012 was the beginning of a new, multiyear upcycle for the stock market?

The stock market has clawed its way upward since the financial crisis hit in 2008. Recent trading volume has been mediocre, accentuating the move, but the majority of companies on the Dow reported solid fourth-quarter earnings.

Corporations are buying back shares, increasing their dividends, and for a lot of blue chips, balance sheets are in excellent shape—way better than before the financial crisis. Valuations are below historical norms.

Bull markets typically start in a stealthy manner. All of a sudden, institutional sentiment changes on a dime. At the beginning of a new upcycle in the stock market, it’s corporate profitability that leads all other metrics. Regrettably, it’s not about Main Street.

Current aggregated data by FactSet on earnings are calling for a solid advance in the bottom half of 2013 and 2014. It may not be believable yet, but many corporations are expecting this.

There is a tremendous amount of cynicism and doubt among individual investors (and rightly so). Many people have been sidelined since the financial crisis and throughout the recession. Since the financial crisis, individual investor sentiment has grown worse. A contrarian indicator? Maybe. Overperformance in the Dow Jones Industrials produced two significant periods of underperformance within the last 12 years. But the normalized trend of the Dow Jones Industrials is good.

Chart courtesy of www.StockCharts.com

The Federal Reserve is absolutely committed to re-inflating assets and keeping interest rates low. U.S. national debt is growing significantly (along with the money supply), but the burden of interest rates on this debt is still well within historical norms, though less so now than in the 80s and 90s. (Source: USGovernmentSpending.com, last accessed March 18, 2013.) Of course, the cost of money is a lot cheaper these days. Perhaps this is the real purpose of the Federal Reserve—to keep inflation-adjusted interest costs affordable for a perpetually rising U.S. gross national debt. (See “The Fed’s Running the Show and Risk Keeps Going Up.”)

Jobs growth is very important in the Main Street economy, but not for corporations. The important metric for corporations is productivity (employee output per hour). U.S. productivity grew by one percent in 2012, 0.7% in 2011, and 3.1% in 2010. I think productivity will be on the upswing this year on the back of improving business conditions for large corporations that don’t need to hire.

The stock market can begin a long-term uptrend in the face of stagnant incomes and minimal jobs growth. Profitability and institutional investor sentiment are what drive share prices. This stock market is due for a major correction, but it’s fairly priced going into first-quarter earnings season.

Stock market action, from the recent financial crisis to now, reminds me a lot of the late 80s and early 90s. After the crash, the stock market recovered strongly, followed by another recession, financial crisis, and then a correction. Then there was a sustained period of rising prices, a rising stock market, a rising money supply, and rising government debt, while productivity and innovation thrived.

This is not conventional thinking right now, and the U.S. economy still needs more time to balance out after the recent financial crisis. U.S. employment growth and Main Street incomes are stagnant, and that’s tough on a huge number of people.

I’m just considering the stock market’s recovery since the financial crisis, its powerful breakout last December, recent economic news, and the business cycle—the stock market isn’t done yet, not by a long shot.

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Forecasts Aug. 2, 2015

Immediate term outlook:
The bear market rally in stocks that started in March 2009, extended because of unprecedented central bank money printing, is coming to an end. Gold bullion is up $1,000 an ounce since we first recommended it in 2002 and we are still bullish on the metal.

Short-to-medium term outlook:
World economies are entering their slowest growth period since 2009. The Chinese economy grew last year at its slowest pace in 24 years. Japan is in recession. The eurozone is in depression. With almost half the S&P 500 companies deriving revenue outside the U.S., slower world economic growth will negatively impact revenue and earnings growth of American companies. Domestically, the U.S. economy is also entering a slow growth phase (1Q15 GDP of -0.7%) which will negatively impact an already overpriced equity market.

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